I am happy to present this week’s market commentary from FormulaFolio Investments. The goal is to give our clients and friends a simple way to see everything they need to know about the financial markets on a weekly basis, in 5 minutes or less. After all, investing should be simple, not complicated.
Equities: Broad equity markets finished the week positive as international stocks experienced the largest gains. S&P 500 sectors finished the week mixed as cyclical sectors generally outperformed defensive sectors.
So far in 2018 technology, materials, and energy are the strongest performers while utilities, real estate, and telecommunications are the only sectors with negative performance year-to-date.
Commodities: Commodities were positive for the third consecutive week as oil prices increased 1.69%. Oil prices are near three-year highs as a decline in the number of US rigs drilling for new production and sustained OPEC output cuts have recently supported prices.
Gold prices rose 0.99% as the dollar declined, marking the fourth straight week of gains for the metal. A weaker dollar makes dollar-denominated assets, such as gold, less expensive for holders of other currencies, pushing prices higher.
Bonds: The 10-year treasury yield rose from 2.40% to 2.47%, resulting in negative performance for treasury and aggregate bonds. Yields have continued to trend higher recently on expectations that the Fed may hike rates faster than originally anticipated amid stronger economic growth and fiscal stimulus in 2018.
High-yield bonds were positive as credit spreads decreased during the week. If the economy remains strong and healthy, higher-yielding bonds are expected to continue outperforming aggregate bonds as they offer higher interest payments and the risk of default is moderately low.
All riskier asset class indices are currently positive in 2018, but treasury and US aggregate bonds are currently negative.
Lesson to be learned: “The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.” – Seth Klarman. Markets tend to move in broad cycles. However, when crisis seems to strike (or even when things appear too good to be true), a herd mentality can form as investors copy the behavior of others because they are influenced to act and think in a certain way. By maintaining a broadly diversified blend of asset classes and eliminating emotions from the investment process when making decisions, you can look to take advantage of the major trends caused from the herd mentality, improving your probability of long-term success.
FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).
In a nutshell, we want the RPI to be low on the scale of 1 to 100. For the US Equity Bull/Bear indicator, we want it to read least 67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.
The Recession Probability Index (RPI) has a current reading of 19.28, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bullish. This means our models believe there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).
Weekly Comments & Charts
The S&P 500 finished positive for the sixth time in seven weeks as the Index started 2018 on a strong note and remains firmly in the upward trend that began in mid-February 2016. Since February 12, 2016, the S&P 500 is up 49.97%. Shorter-term momentum has increased as the Index recorded fresh all-time highs and experienced its strongest week of gains in over a year, illustrating there may still be further gains ahead. Stock markets are still in a historically low risk and volatility environment as there has not been a 5%+ correction for the S&P 500 in 385 trading days – the third longest streak in the history of the Index. The coming weeks should continue to provide valuable insight about the near-term direction of the S&P 500, but it seems to remain in a bullish pattern for now.
*Chart created at StockCharts.com
While the past week started a new year, it appeared to be a continuation of 2017 as major US indices recorded new all-time highs and volatility reached new all-time lows.
US markets started the year strong as the Dow Jones Industrial Average reached 25,000 for the first time and the S&P 500 recorded its best weekly performance in over a year. As stocks continued to push higher, the CBOE Volatility Index (VIX) reached a new record low during the week, falling to 9.01.
Many economic data points – including US manufacturing, construction spending, and auto sales – surprised on the upside. However, the heavily watched jobs report on Friday was somewhat disappointing as payroll employment increased by only 148,000 compared to the expected 188,000 increase. Though this was lower than expected, the trailing three-month average remained above 200,000 and the unemployment rate remained unchanged at 4.1%, indicating the overall labor market remains healthy.
The mostly positive economic data, as well two consecutive quarters of GDP growth above 3%, has provided a strong foundation to support the markets in 2018.
Though the prospects of 2018 appear positive as we start the year, economic data and market sentiment can change quickly. This is why it is still important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results, rather than chasing short-term returns.
As investors, we need to stay committed to our long-term financial goals. All the short-term news and market movements can be the most debilitating of all when it comes to making sound investment decisions; especially if we allow them to influence knee-jerk decisions.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst
*Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.